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Opinions of Saturday, 28 March 2015

Columnist: Sintim-Agyeman, Seth

The fate of 3rd world economies in the era of quantitative easing


The 3rd World or emerging economies have had a tall mountain to climb since the 2008 global financial meltdown. Argentina has defaulted on its sovereign bonds, and Brazil’s economy is gasping for air. Portugal, Ireland, Italy, Greece, and Spain are still staggering; while South Africa, Nigeria and Ghana, including many prominent African Countries that showed signs of prosperity within the first decade of the millennium, are grappling with their fair share of the adverse economic effect of the financial meltdown.

Quantitative easing (QE) has been a popular technical term thrown around in the post-meltdown era. Japan was the first Country to improperly adopt QE at the early stages of the millennium. However, QE is gradually taking shape as a viable financial policy tool, after the US Federal Reserve (the Fed) had somewhat efficiently implemented it to avert the harsh economic consequences which might have wrecked the US economy. Now, the European Monetary Union, China and many other industrialized and frontier economies are flexing their muscles to implement quantitative easing to resuscitate their respective economies. Nonetheless, my unease lies in the following question - Can 3rd World economies follow suit and successfully emulate the United States to implement quantitative easing? Fundamentally, the United States QE policy exploited the combination of the following four elements to subdue deflation and economic stagnation:

1. Minting Fiat Currency with the Exploitation of Accounting and Technology.

2. Lowering Short Term Interest Rates to Almost 0%.

3. Reducing Taxation, and

4. The Fed’s Purchases of Treasury Securities, MBS’ and other Financial Assets.

Synopsis of the Fed’s Actions in the Implementation of the QE Policy So far, QE has proven to be a workable tool for the United States Federal Reserve. The U.S. economy has shown signs of stability and a propensity towards growth after the aggressive implementation of the combined elements of quantitative easing. Financial elites had been very apprehensive about the probability of a severe deterioration of the U.S. dollar, and the ultimate likelihood for hyper- inflationary pressure on the U.S. economy. However, none of the anticipated adverse effects has yet happened.

The Fed started the QE policy implementation process with an initial purchase of $600 billion dollar worth of Mortgage Backed Securities (MBS) in November 2008, and peaked at a total injection of over $2.1 trillion by June 2010, on combined-purchases of Treasury securities, MBS and other financial assets. The fear for a probable deterioration of the U.S. dollar due to the huge capital injection prompted an exponential surge in the price of gold. Investors sought for a safe haven in gold as the alternate mechanism to hedge against the anticipated fall of the U.S. Dollar.

The price for an ounce of gold rose to an all-time high of $1,921.60 on September 6, 2011, from as low as $271.10 per ounce at the dawn of the millennium in January 2001 – accounting for a surge of more than 609% in a little over a period of one decade. The Fed continued on a second phase of the QE policy from November 2011, with a purchase of $600 billion worth of Treasury securities together with an additional investment of $250 to $300 billion in Treasuries, using the profit earned from the first phase of the Fed’s capital injection. During the third phase of the QE which started in September 2012, the Fed resorted to monthly purchases of $40 billion of financial assets, instead of the usual bulk purchases. Then, the monthly capital injection was raised to $85 billion worth of treasury purchases per month by December 2012.

Alongside the Fed’s money printing and aggressive capital injection, the Fed lowered short term interest rates to almost O % to encourage the banks to borrow more from the Fed and invest to resuscitate the economy. Also, the US Federal Government enacted income tax cuts and other stimulus packages to increase disposable income in people’s pockets to boost consumer spending to further resuscitate the economy. Effect of QE on the U.S. Economy The injected capital was able to be contained within the walls of the financial institutions, because the Fed exploited accounting entries (Debit/Credits) and interbank wire transfers to execute the QE policy. Actual printing of fiat currency was kept very minimal. And, commercial banks made very few loans to very qualified mortgage and business loan applicants. Ultimately, the bulk of the money which the Fed had injected into the financial institutions was invested in the capital markets; and, has therefore resulted in an extravagant stock market with a slow growth mainstream economy.

Furthermore, studies have shown that American consumers are more likely to transact business electronically (through Debit or Credit cards) or by Checks, if the transaction size exceeds $50. As a result, the need for physical cash or fiat currency in circulation is gradually dwindling, and is giving financial institutions more control over money in circulation to further driving down the propensity for hyper-inflation on the economy. Also, acceptance of the U.S. dollar as an international currency has increased global demand for the currency. Analysts have estimated that more than 60% of total dollars in circulation are kept outside the borders of the United States, which also reduces inflationary pressure on the U.S. economy. Can 3rd World and Frontier Economies Imitate the U.S. QE Policy? Instantly, the answer is a big NO! Attempts could be made in different approaches, but taking a symmetric stance to mimic the above outlined elements of U.S. Federal Reserve’s QE policy implementation approach to resuscitate any 3rd World economy would be a catastrophic endeavor, because, the dominating element of the QE policy focused on money or liquidity creation. And, the premise for my firm assertion is supported with the following challenges found in most 3rd World and frontier economies:

1. Negative Balance of Trade.

2. Dollarization and Local Currency Valuation Crises.

3. Semi-Developed Financial Institutions and Capital Markets, and

4. Undeveloped Mortgage Debt Markets.

Effect of Negative Balance of Trade

Globalization has exposed many 3rd World economies, and has developed insatiable taste for consumption of foreign manufactured products. Besides, most 3rd world economies only export low-priced raw materials or semi-processed goods at lower costs, and, import expensive finished goods to feed their respective fragile economies.

Consequently, high demand for consumer goods, such as automobile; petroleum; electronics; medicine; processed foods; clothing; etc., has resulted in excess imports of consumer products over the export of raw materials to create trade imbalances or net trade deficits in many 3rd World economies. And, because their respective local currencies are not acceptable for international transactions, emerging economies are forced to borrow in dollars at higher interest rates (considering risk of default) to offset their international trade deficits. And, repetition of such deficit cycles is creating huge debts and interest obligations for many 3rd World economies.

Dollarization and Local Currency Valuation Crises

As indicated above, insatiable taste for foreign products in 3rd World economies has created a huge increase in demand for the U.S. dollar at the expense of their local currencies. The U.S. dollar is tendered alongside local currencies to the extent that certain organizations only accept U.S. dollars, and quote prices for their goods and services in dollars. Thus, excessive demand for the dollar to execute both local and international business transactions, and the dollar acting as a better store of value, has caused erratic fluctuations in the value of local currencies. Hence, declaration by any 3rd World Central Bank Governor to introduce quantitative easing as a policy to increase liquidity and to resuscitate their local economies would be fiasco – it would rather worsen the situation. The people would be forced to discard the local currency and seek a safe haven in the U.S. dollar, just like Americans and the investment world rushed for gold in 2011.

Semi-Developed Financial Institutions and Capital Markets

The sophisticated nature of the U.S. financial system tamed the anticipated hyper-inflationary effect on the U.S. economy which the Fed’s $4.5 trillion capital injection might have caused. However, the same cannot be said about 3rd World economies. Banks in most 3rd World economies transact business in “savings and loans,” without any sophisticated financial derivatives transactions or any dynamic repurchase (Repo) or reverse repurchase (Reverse-Repo) activities. Besides, electronic banking and electronic commerce have not matured in 3rd World economies, and so, more than 90% of commercial transactions are cash-based.

Also, Capital markets in 3rd World economies are not developed. Securities in the stock exchanges are thinly traded and illiquid. Therefore, financial institutions and the capital markets are not sophisticated enough to absorb any huge capital injection by the central banks. Thus, suspension mechanisms required for a smooth implementation of quantitative easing are not yet established to cushion or slow-down the flow of cash from central banks to the consumer public. Consequently, any massive capital injections would flow directly through the mainstream economy to create hyper-inflationary shocks, and deteriorate the economic wealth of the people. Undeveloped Mortgage Loan Markets Apart from the Fed’s direct injection of capital into U.S. Treasury securities, the Fed embarked on aggressive purchases of Mortgage Backed Securities from the investment banks to facilitate the banks with enough liquidity to gradually; selectively; and, electronically lend to small businesses, and to the general public as mortgage loans for home acquisitions, home improvements, and as car loans to spin or stimulate the economy without directly injecting physical cash. Such electronic mechanisms and mortgage debt derivatives market operations are new concepts to most 3rd World economies, and may take a few decades for such sophisticated systems to fully catch on. Interest Rates and Taxation As the Fed’s Fund Rates have been cut to a near 0% in the United States for six consecutive years, Prime Interest Rates in emerging economies are hovering around the average of 15%, due to inherent default risks associated with lending to 3rd World economies. Thus, International Capital Markets are forced to protect their investments in 3rd World economies by demanding such high interest rates in advance, to offset the probability of future defaults. Furthermore, taxation is the major source of revenue for the United States government, so efficient tax systems are in place to track both Individual and Corporate incomes and their applicable tax revenues. Therefore the government was able to introduce tax cuts in certain demographics and emerging industries to enhance the resuscitation of the economy. This, on the other hand, cannot be attributed to governments in the 3rd World economies. The 3rd World economies have no systems in place to efficiently track individual and corporate revenues, so governments are already losing billions of dollars to multinational corporations. Consequently, enacting tax cuts and other tax regulations in line with that of the United States to stimulate 3rd World economies would yield very insignificant results.


Considering the foregoing and other challenging factors, 3 rd World economies are functioning in very rigid conditions that call for critical structural shifts and re-positioning to develop economic freedom. Else, the next decade would fetch a lot of social uprising in many emerging economies around the world. Nonetheless, I would conclude on the assertion that 3rd World economies are not yet ready to imitate the United States, the United Kingdom, and other advanced economies in the implementation of quantitative easing. There are strategic and innovative policies that emerging economies can implement to strengthen their currencies and stimulate or resuscitate their fledging economies irrespective of quantitative easing. And, such details would be covered in my next publication, stay tuned.

Seth Sintim-Agyeman, MBA, CPA

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